CORNERSTONE REALTY INCOME TRUST
                              BUILT ON PERFORMANCE

CONTENTS

 1   FINANCIAL HIGHLIGHTS

 3   LETTER TO SHAREHOLDERS

 6   BUILT ON PERFORMANCE

 7   THE PROPERTIES

20   BOARD OF DIRECTORS

21   SELECTED FINANCIAL DATA

22   MANAGEMENT'S DISCUSSION

27   INDEPENDENT AUDITORS' REPORT

28   BALANCE SHEETS

29   STATEMENTS OF OPERATIONS

30   STATEMENTS OF SHAREHOLDERS' EQUITY

31   STATEMENTS OF CASH FLOWS

32   NOTES TO FINANCIAL STATEMENTS

39   INVESTOR INFORMATION

CORPORATE PROFILE

Cornerstone  Realty Income Trust,  founded in 1993, is a real estate  investment
trust which owns and manages apartment communities in 16 distinct markets of the
southeastern  United States. We are a fully integrated,  self-administered  real
estate company headquartered in Richmond, Virginia with regional offices located
throughout our four-state operating territory.  Our shares trade on the New York
Stock  Exchange  under the ticker symbol TCR. Since  operations  began,  we have
provided shareholders with steadily increasing distributions.

     Our mission is to achieve growing profits and sustained corporate value for
our  sharehlders;  provide  high-quality,  expertly  managed  rental housing for
residents;  and  foster  an  enterpreneurial,   results-driven  environment  for
employees. We specialize in opportunistic  acquisitions  cost-effective property
repositioning; and expert management to acheive the properties' highest economic
potential.

     At December 31, 1997, we owned 51 apartment communities,  containing 11,922
apartments, located in Virginia, North Carolina, South Carolina, and Georgia.

FINANCIAL HIGHLIGHTS

                               [GRAPHIC OMITTED]


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
<S>                              <C>                                       <C>                <C>              <C>
                                 Years Ended December 31,                            1997               1996              1995
OPERATING RESULTS                Rental Income                             $   70,115,678      $  40,261,674   $    16,266,610
                                 Net Income (Loss)                             19,225,553         (4,169,849)        5,229,715
                                 Funds from Operations (a)                     34,792,053         20,424,226         8,018,533
                                 Distributions Declared and Paid               31,324,870         15,934,901         6,316,185


BALANCE SHEET DATA               Investment in Rental Property             $  487,575,196      $ 329,715,853    $  129,696,447
                                 Total Assets                              $  474,186,450      $ 322,870,574    $  133,181,032
                                 Shareholders' Equity                      $  315,328,252      $ 254,569,705    $  122,154,420
                                 Shares Outstanding                            35,510,327         28,141,509        12,754,331
</TABLE>

     (a) "Funds from  operations"  is defined as income before gains (losses) on
     investments and extraordinary  items (computed in accordance with generally
     accepted  accounting  principles)  plus real estate  depreciation and after
     adjustment for  significant  nonrecurring  items,  if any. This  definition
     conforms to the  recommendations  set forth in a White Paper adopted by the
     National Association of Real Estate Investment Trusts (NAREIT).  Funds from
     operations  for years  prior to 1996 have been  adjusted  to conform to the
     NAREITdefinition. The company considers funds from operations in evaluating
     property  acquisitions  and its  operating  performance,  and believes that
     funds  from  operations  should be  considered  along  with,  but not as an
     alternative  to, net  income  and cash flows as a measure of the  company's
     operating performance and liquidity.  Funds from operations,  which may not
     be comparable to other similarly  titled measures of other REITs,  does not
     represent  cash  generated  from  operating  activities in accordance  with
     generally accepted accounting principles and is not necessarily  indicative
     of cash available to fund cash needs.


<PAGE>



TO OUR SHAREHOLDERS:

It is my great  privilege  to present  the 1997  annual  report for  Cornerstone
Realty Income Trust.

     This year we celebrate  the strong  performance  on which we have built our
company.  Since 1993,  Cornerstone  has grown steadily from a new company into a
publicly traded real estate investment trust with a total market  capitalization
exceeding $600 million.

     We have met our goals every step of the way--

          building a strong  portfolio of apartment  communities  that stretches
          over 16 distinct markets in four southeastern states;

          achieving   steadily  growing  income  from  the  properties  we  own;

          generating increasing returns to our shareholders;

          and,  in 1997,  culminating  the growth of our early  years by listing
          shares on the New York Stock Exchange as TCR, The Cornerstone REIT.


STRONG OPERATING RESULTS

During 1997, we achieved excellent operating results from our properties. Rental
income grew to $70.1 million,  an increase of 74% over the previous year's $40.3
million.  This  dramatic  increase  largely  reflects  growth in the size of our
portfolio  over  the  past  two  years.  Our  expertise  in  repositioning   the
properties,  through  a  sophisticated  blend  of  renovations,   marketing  and
management, will result in significant increases in income.

     Funds from  operations  (FFO) grew to $1.07 per share,  a 6% increase  over
1996. FFO totaled $34.8 million,  up 70% from $20.4 million in 1996. This strong
increase  resulted  from a  combination  of  internal  growth--achieving  higher
returns  from  properties  we  already  own--and  external  growth  through  the
acquisition of additional properties.

     A look at the performance of those  properties  owned by Cornerstone for at
least two years  demonstrates our success in generating  steadily higher returns
from our portfolio  over the long term. We call this "same  property"  operating
results,  defining  "same  property"  with  reference  to the  core  group of 19
properties  we have  continuously  owned  since the end of 1995.  Net  operating
income from these properties increased by 7.4% in 1997.

BUILDING THE CORNERSTONE PORTFOLIO

In 1997, we continued to find excellent  opportunities to acquire apartments for
the Cornerstone  portfolio,  purchasing 13 properties for a total of 2,889 units
by year's end. We significantly increased our holdings in existing markets while
making inroads into a new primary market for the company,  Atlanta. We continued
to acquire  properties  within our  niche--those  which can enjoy  significantly
higher income  streams by bringing them up to  Cornerstone's  high standards and
repositioning  them in the  marketplace.  But we also continued to diversify our
portfolio  with a  substantial  number  of  newer  communities  requiring  fewer
renovations.

     In Atlanta, we acquired 1,129 apartments in four properties over the course
of the year. With one of the strongest  economies of any major urban area in the
United  States,  Atlanta led the nation in new-job  growth  during the past four
years. In the last decade,  this dynamic  southern city increased  population by
32%,  created  nearly a  half-million  new jobs,  and attracted  over 400 of the
Fortune 500 industrial firms, and 350 of the Fortune 500 service firms.

     We targeted Atlanta because we found opportunities to acquire properties in
excellent locations which could benefit from market  repositioning.  This is our
specialty -- generating higher income from existing  properties through selected
renovations, strategic marketing and focused, results-oriented management. These
properties  may not meet our  standards  when we first  acquire  them.  However,
ensuing renovations and repositioning  results in top-of-the-line  properties in
great locations.  Demand for well-managed apartments remained steady in Atlanta,
despite construction of new properties.

     We  substantially  increased  our  penetration  in  both  the  Raleigh  and
Charlotte  markets  during 1997.  In Charlotte,  we added two  properties to our
portfolio,  bringing our total investment in this southeastern  financial center
at  year-end  to 2,291  units in nine  apartment  communities.  In  Raleigh,

                                      -3-

<PAGE>



we acquired an additional 762  apartments in five  properties.  Cornerstone  now
owns 11  properties  in the  Raleigh/Durham  area, a total of 2,152 units.  This
fastest-growing   North  Carolina  metropolis  continued  to  show  very  strong
occupancy  levels,  the highest  among our  markets.  Additionally,  we acquired
properties in Columbia and Charleston, South Carolina during the year.

     Overall, Cornerstone's markets--selected because of their strong demand for
multifamily  housing and potential for  growth--continued  to perform very well.
Our  six  primary  markets  are  Raleigh/  Durham,  Virginia  Beach,  Charlotte,
Richmond, Greenville and Atlanta. We also have 10 smaller markets, which include
Wilmington and Asheville in North  Carolina;  Charleston,  South  Carolina;  and
Lynchburg,  Virginia.  Many of these smaller markets  actually  outperformed our
primary markets in 1997.

A NYSE-TRADED COMPANY

On April 18, 1997, three years of growth  culminated when  Cornerstone's  shares
were listed  under the symbol TCR (The  Cornerstone  REIT) on the New York Stock
Exchange.  At this  historic  moment,  we achieved our goal to trade shares on a
major stock exchange after reaching initial  capitalization  through the sale of
approximately 28.1 million shares.

     In conjunction with trading, we completed an offering of 4.5 million shares
of  Cornerstone  stock.  Led by a  distinguished  team of managing  underwriting
firms--Alex.  Brown & Sons  Incorporated;  Branch  Cabell & Co. Inc.;  Friedman,
Billings,  Ramsey & Co.; and Interstate Johnson Lane--the offering raised $47.25
million in net proceeds for the company.  The proceeds were used to pay down the
company's unsecured line of credit for the financing of property acquisitions.

     Demand  for TCR shares was so high that the  underwriters  exercised  their
entire greenshoe,  or over-allotment  option, to purchase an additional  675,000
shares of stock.  This  brought  approximately  $6.6 million in  additional  net
proceeds to the company.

HIGHER RETURNS FOR THE SHAREHOLDERS

During 1997, our shareholders  profited from the properties'  strong performance
with increases in dividends and share value. Shareholder dividends increased for
the fourth  consecutive year, to an annual dividend rate of $1.00 per share paid
on a quarterly basis.

     The value of Cornerstone's shares grew approximately 15% from their initial
trading  price of $10.50 per share to $12.06  per share by  December  31,  1997.
Combining  this with  growth  in  dividends  gives a total  return of 21% to the
shareholders, or an annualized return of approximately 29%.

     In January,  the  company's  Board of  Directors  announced  an increase in
per-share dividends to $.26 cents each quarter, which represents an annual yield
of $1.04 per share.  Based on the  closing  price of $12.00 per share on January
12, 1998, the new dividend,  when paid, would represent an annual dividend yield
of 8.67%.

     We will continue to build on the strong  performance of Cornerstone  Realty
Income  Trust,  managing our portfolio  with the goal of  generating  increasing
returns for our  shareholders.  This  internal  growth,  building  revenues from
existing properties,  is our primary goal. However,  excellent  opportunities to
acquire properties which meet our investment criteria continue to arise. It will
be through a combination of internal and external growth that we seek to provide
our shareholders with increasing returns in the coming years.

Sincerely,

/s/ Glade M. Knight
Glade M. Knight
Chairman of the Board

                                      -4-

<PAGE>

HIGHLIGHTS OF PERFORMANCE IN 1997:

CORNERSTONE SHARES BEGAN TRADING ON THE NEW YORK STOCK EXCHANGE,
under the ticker symbol TCR, on April 18, 1997. This  culminated  three years of
growth and 28.1 million shares issued under a series of  best-efforts  offerings
by David Lerner Associates.

WE BUILT OUR PORTFOLIO TO 51 APARTMENT COMMUNITIES CONTAINING 11,922 APARTMENTS.
We acquired 13 apartment communities,  containing 2,889 units, for $131 million.
Our assets grew over 48%.

FUNDS FROM  OPERATIONS  (FFO)  EQUALED  $1.07 PER SHARE,  a  six-cents-per-share
increase over 1996. FFO totaled $34.8 million for 1997.

RENTAL INCOME GREW TO $70.1 MILLION, an increase of 74%.

SHAREHOLDER DIVIDENDS INCREASED FOR THE FOURTH CONSECUTIVE YEAR.
In 1997,  the company had an annual  dividend  rate of $1.00 per share,  payable
quarterly.

"SAME PROPERTY" NET OPERATING  INCOME (NOI) INCREASED  7.4%,  demonstrating  our
ability to steadily  build  income from the existing  portfolio  of  properties.
"Same property" refers to the core group of 19 properties  continuously owned by
the company since January 1, 1996.

ECONOMIC OCCUPANCY OF OUR APARTMENT COMMUNITIES AVERAGED 92%.

WE INVESTED $23 MILLION IN PLANNED RENOVATIONS  designed to reposition our newly
acquired properties and generate higher rents.

WE  SUCCESSFULLY  COMPLETED AN OFFERING OF $4.5 MILLION  SHARES OF TCR,  RAISING
$47.25 MILLION IN NET PROCEEDS, in conjunction with initial trading on the NYSE.
The underwriters  exercised 100% of their  over-allotment  option to purchase an
additional  675,000 shares of common stock. This brought additional net proceeds
to the company of approximately $6.6 million.

SHARE VALUE OF TCR GREW APPROXIMATELY 15% FROM THE INITIAL TRADING
PRICE of $10.50 per share in April to $12.06 per share at year-end,  for a total
return, including dividends, of 21% in less than nine months.

SHAREHOLDERS  REINVESTED  OVER $14 MILLION in the company  through our  dividend
reinvestment plan.

WE  STRENGTHENED  OUR  ACQUISITION  CAPABILITY  BY  NEGOTIATING  A $175 MILLION,
UNSECURED  LINE OF CREDIT AT A FAVORABLE  RATE.  This enables us to quickly take
advantage of  acquisition  opportunities  at a variable rate of 120 basis points
over LIBOR.  With this rate, we achieved an initial reduction of 40 basis points
from our previous line of credit.

WE GENERATED $1.85 MILLION IN ADDITIONAL  INCOME FROM  MANAGEMENT,  ADVISORY AND
ACQUISITION FEES FROM APPLE RESIDENTIAL INCOME TRUST.
Structured like Cornerstone, with the same investment strategy, Apple focuses on
the Dallas/Fort Worth, Texas market.

Cornerstone  Realty  Income Trust began  trading on the New York Stock  Exchange
April 18, 1997.

                                       -5-

<PAGE>

BUILT ON PERFORMANCE

The performance of Cornerstone  Realty Income Trust is rooted in our fundamental
investment strategy to acquire properties and manage them to achieve the highest
returns possible. This basic strategy remains unchanged.

     Our performance is fueled by a combination of  opportunistic  acquisitions,
cost-effective  property  repositioning,  and expert  management  to achieve the
properties' highest potential.

     Acquisitions begin in the marketplace.  Cornerstone  acquires properties in
four  of the  fastest-growing  states  in  the  United  States--Virginia,  North
Carolina,  South  Carolina and Georgia.  The U.S.  Census Bureau  predicts these
states will grow by more than 7.6 million people from 1995 to 2025.

     In this four-state region, we have penetrated 16 distinct markets noted for
their dynamic growth and potential for growth. They offer thriving economies and
rapidly  expanding   manufacturing,   technology,   transportation  and  service
industries. Moreover, the properties we acquire in these markets are targeted to
the single largest sector of the renting public in the U.S.

     We  acquire  properties  at  well  below  replacement  cost.  Cornerstone's
acquisitions  average $35,000 per unit, nearly half the $60,000 replacement cost
estimated  in our market  niche.  That's  because we have the ability to unearth
excellent acquisition  opportunities and move quickly to take advantage of them.
We tend to  acquire  properties  which,  for a  variety  of  reasons,  have  not
performed to their potential.  They may suffer from deferred  maintenance,  poor
management,  the  financial  distress  of a previous  owner,  or a host of other
factors.

     We are experts at repositioning properties into high performers. As soon as
we  acquire  a  property  we deploy a  "takeover  team" of  property  management
executives and specialists in marketing,  resident  retention and maintenance to
the site. This group brings  operating  systems up to Cornerstone  standards and
remains at the property until a new on-site team is installed and trained.

     Meanwhile,  our engineering and construction  specialists go to work making
cost-effective  renovations designed to improve the property's marketability and
generate  higher  rents.  We may  re-landscape;  design new  signs;  build a new
clubhouse;  add new roofs; or paint.  Rents are raised to reflect the property's
enhanced value, and a sophisticated marketing program is launched to attract new
residents at higher rents.

     Once a property is repositioned in its marketplace,  our management experts
focus on maximizing income by generating the highest rents possible, maintaining
high occupancy rates, and continually seeking ways to reduce operating costs. It
can be a  delicate  balance.  That's  why we  provide  our  sites  with the most
advanced,  high-technology  systems available in property management today. It's
why we hire the best people in the  industry,  train them well,  and give them a
workplace that encourages innovation and entrepreneurship.

     Which brings us back to performance.  When our people perform well, so does
the company.  And when the company performs well, we reward our people.  BECAUSE
AT CORNERSTONE, PERFORMANCE IS THE STANDARD.

                                      -6-

<PAGE>



BRIDGETOWN BAY

Every new visitor to Bridgetown Bay passes before the striking Palladian windows
fronting the rental  office and  clubhouse of this luxury  apartment  community.
Sunlight filters through  two-story  windows into the front office where leasing
agents meet with  prospective  residents.  In the rear clubhouse,  a wide-screen
television and comfortable  furniture await residents seeking respite from their
busy lives.

     Details like tiled fireplaces, vaulted ceilings, bay windows and room-sized
decks make the 120 apartments of this  Charlotte  community  special.  Residents
enjoy a swimming pool, playground and their own private,  lighted walkway to the
retail shops of nearby East Town Market.



                                      -7-
<PAGE>

CHARLESTON PLACE

In the  elegant  clubhouse  of  Charleston  Place,  residents  can  relax by the
fireplace and peruse a book borrowed from the community's  own library.  If more
actively  inclined,  they  can  work out in a  state-of-the-art  fitness  center
overlooking the swimming pool. Or wander the walking trails of this  beautifully
landscaped, 214-unit apartment community to Char-lotte's McAlpine Greenway Park.
These apartments have a custom feel, with built-in shelves, vaulted ceilings and
large picture windows.




                                      -8-
<PAGE>

SAVANNAH WEST

In the graceful rooms of the Savannah West clubhouse, the charm of the old South
blends with the comfort of the new.  This  elegant  community  of 456  apartment
homes in Augusta, Georgia is located across from the famed Augusta National Golf
Course,  not far from the waters of the Savannah  River.



                                      -9-
<PAGE>

PARKSIDE AT WOODLAKE

A gorgeous  swimming  pool is one of many  luxuries  afforded  to  residents  of
Parkside  at  Woodlake.  They can also enjoy their own  private  putting  green.
Construction of this 266-unit  apartment  community in Durham was just completed
in 1996. A city park adjacent to the property offers soccer and baseball fields,
picnic areas, a jogging path, tennis courts and playground areas.



                                      -10-
<PAGE>

CARLYLE CLUB

Some may find it hard to  distinguish  the lush lawns of  Carlyle  Club from the
beautifully  manicured  greens of the bordering  Northwoods  Country Club.  This
243-unit  community outside Atlanta offers stunning golf course views. Among its
park-like  grounds are two small lakes,  two swimming  pools, a tennis court and
playground.  Nine  apartment  styles  provide up to 1600  square  feet of space,
accommodating a variety of family sizes.



                                      -11-
<PAGE>

PACES GLEN

Beautiful landscaping is a hallmark of Paces Glen, a community of 172 apartments
in Charlotte,  North Carolina. This is a place where picnics are encouraged. The
28-acre property contains a special picnic area,  complete with gas grills and a
gazebo.  Residents  can work off  picnic  feasts on the  tennis  court,  or in a
private  fitness  center  where  they can cycle,  lift,  tread and step to their
heart's desire.



                                      -12-
<PAGE>

SUMMERWALK

Summerwalk offers suburban living in a rustic and secluded setting convenient to
downtown Charlotte.  Residents can fish from their own lake or hike a variety of
trails through the 26-acre grounds.  Amenities of the community's 160 apartments
include cathedral ceilings and fireplaces. Two tennis courts and a swimming pool
round out the features of this luxury apartment community.

                                      -13-

<PAGE>



HIGHLAND HILLS

Minutes from the intellectual hives of Research Triangle Park, the University of
North Carolina and Duke  University,  Highland Hills is a haven among  apartment
communities.  When not working,  residents can recline among the warm,  swirling
waters of a Jacuzzi,  soak up sun in the privacy of a tanning bed,  swim laps or
play tennis. The spacious grounds of Highland Hills contain 45 acres.



                                      -14-
<PAGE>

THE ARBORS AT WINDSOR LAKE

Extraordinary  service is an ordinary  affair at The Arbors at Windsor Lake. The
people who live here can avail  themselves  of covered  parking,  extra  storage
spaces or a resident executive center with fax and copy machines. This Columbia,
South  Carolina  community  also  contains a swimming pool with spa, two lighted
tennis courts,  a fitness center,  and 228 apartments with luxuries like natural
gas fireplaces,  vaulted ceilings,  full-sized  washers and dryers, and spacious
walk-in closets.



                                      -15-
<PAGE>

SAILBOAT BAY

The exquisite clubhouse of Sailboat Bay shares lake views with several apartment
buildings on this 358-unit  property in Charlotte.  Since extensive  renovations
were com-pleted,  passersby often mistake the 20-year-old  community for a newly
constructed one. Sailboat Bay is a gated community, offering a fitness center, a
swimming pool, and courts for racquetball, tennis and volleyball.



                                      -16-
<PAGE>

CLARION CROSSING

Residents  can picnic  along a tumbling  stream in tranquil  woods  without ever
leaving the grounds of Raleigh's Clarion Crossing. Nor do they have to leave for
a work-out.  This  community of 228 apartments  offers a fully equipped  fitness
center,  two tennis  courts  and a swimming  pool.  And  should--after  all this
activity--a  nap  beckon,  there is always  the huge,  sun-drenched  deck of the
clubhouse overlooking the swimming pool.



                                       -17-
<PAGE>

DEERFIELD

From the privacy of their  screened  porches,  residents of Deerfield  can enjoy
wooded  seclusion.  This luxury community of 204 apartments is minutes away from
central  Durham,  yet  offers  direct  access to miles of  beautiful  trails for
walking,  jogging  or cycling  within  the  bordering  nature  preserve  of Duke
University.  Residents  can relax in the  property's  heated  whirlpool,  on the
tennis courts or in the pool.

                                      -18-

<PAGE>

PACES ARBOR/PACES FOREST

The lushly landscaped pool areas of Paces Arbor/Paces Forest offer the choice of
napping in sun or shade--on  the warm wooden planks of an elevated deck or under
the canopy of a poolside gazebo.  Gas grills and a relaxing Jacuzzi complete the
scene. These Raleigh,  North Carolina apartment communities contain garden-style
apartments with a choice of amenities like beautiful  wooded views,  fireplaces,
washers, dryers and vaulted ceilings.

                                      -19-

<PAGE>


BOARD OF DIRECTORS

Glade M. Knight (1)                     Penelope W. Kyle (2),(3)
  Chairman of the Board of                Director, Virginia State
  Chief Executive Officer                 Lottery

S.J. Olander, Jr.                       Harry S. Taubenfeld
  Senior Vice President and               Real Estate Investor and
  Chief Financial Officer                 Partner, Zuckerbrod &
                                          Taubenfeld, Esqs.
Glenn W. Bunting, Jr. (1),(2)
  President, KB Properties, Inc.        Martin Zuckerbrod (1)
                                          Real Estate Investor and
Leselie A. Grandis (2)(3)                 Partner, Zuckerbrod &
  Partner, McGuire, Woods,                Taubenfeld, Esqs.
  Battle & Boothe LLP
                                        (1) Member, Executive Committee
                                        (2) Member Audit Committee
                                        (3) Member, Compensation Committee



                                   -20-

<PAGE>

SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>

As of December 31,                                       1997            1996            1995             1994            1993
---------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>              <C>             <C>              <C>            <C>
OPERATING RESULTS

Rental Income                                  $   70,115,678   $  40,261,674   $  16,266,610    $   8,158,994  $    1,778,568
Net Income (Loss)                                  19,225,553      (4,169,849)      5,229,715        2,386,303         496,646
Distributions Declared and Paid                    31,324,870      15,934,901       6,316,185        2,977,136         359,427
---------------------------------------------------------------------------------------------------------------------------
PER SHARE

Net Income (Loss) (a)                          $          .59   $       (0.21)  $        0.64    $        0.60  $         0.30
Distributions                                  $         1.00   $        0.99   $        0.96    $        0.89  $         0.27
Distributions Representing Return of Capital               23%             14%             17%              21%             --
Weighted Average Shares Outstanding                32,617,823      20,210,432       8,176,803        4,000,558       1,662,944
------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA

Investment in Rental Property                  $  487,575,196   $ 329,715,853   $ 129,696,447    $  54,107,358  $   25,549,790
Total Assets                                   $  474,186,450   $ 322,870,574   $ 133,181,032    $  57,257,950  $   29,199,079
Notes Payable                                  $  151,569,147   $  55,403,000   $   8,300,000    $   5,000,000  $           --
Shareholders' Equity                           $  315,328,252   $ 254,569,705   $ 122,154,420    $  51,436,863  $   28,090,912
Shares Outstanding                                 35,510,327      28,141,509      12,754,331        5,458,648       2,995,210
------------------------------------------------------------------------------------------------------------------------------
OTHER DATA
Cash Flows from:

  Operating Activities                         $   34,973,533   $  20,162,776   $   9,618,956    $   3,718,086  $    1,670,406
  Investing Activities                         $ (161,969,343)  $(194,519,406)  $ (75,589,089)   $ (28,557,568) $  (25,549,790)
  Financing Activities                         $  128,327,145   $ 170,466,134   $  68,754,842    $  25,519,648  $   27,487,556
Number of Properties Owned at Year-End                     51              40              19                9               5
------------------------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS CALCULATION

  Net Income (Loss)                            $   19,225,553   $  (4,169,849)  $   5,229,715    $   2,386,303  $      496,646
     Depreciation of Real Estate                   15,163,593       8,068,063       2,788,818        1,210,818         255,338
     Management Contract Termination (b)              402,907      16,526,012              --               --              --
                                               -------------------------------------------------------------------------------
  Funds from Operations (c)                    $   34,792,053   $  20,424,226   $   8,018,533    $   3,597,121  $      751,984
==============================================================================================================================

</TABLE>



(a) In 1997, the Financial  Accounting  Standards Board issued Statement No. 128
"Earnings  per Shares." All earnings per share amounts for all periods have been
presented,  and where appropriate,  restated to conform to the Statement No. 128
requirements.

(b)  Included  in  the  1997  and  1996  operating   results  are  $402,907  and
$16,526,012,  respectively, of management contract termination expense resulting
from the company's conversion to "self-administered"  and "self-managed" status.
See Note 6 to the consolidated financial statements.

(c) "Funds  from  operations"  is defined as income  before  gains  (losses)  on
investments  and  extraordinary  items  (computed in accordance  with  generally
accepted  accounting   principles)  plus  real  estate  depreciation  and  after
adjustment for significant  nonrecurring items, if any. This definition conforms
to the  recommendations  set  forth in a White  Paper  adopted  by the  National
Association of Real Estate Investment Trusts (NAREIT). Funds from operations for
years prior to 1996 have been adjusted to conform to the  NAREITdefinition.  The
company considers funds from operations in evaluating property  acquisitions and
its operating  performance,  and believes that funds from  operations  should be
considered  along with, but not as an alternative  to, net income and cash flows
as a measure of the company's  operating  performance and liquidity.  Funds from
operations,  which may not be comparable to other  similarly  titled measures of
other REITs,  does not represent cash  generated  from  operating  activities in
accordance with generally accepted accounting  principles and is not necessarily
indicative of cash available to fund cash needs.

                                      -21-

<PAGE>



MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

OVERVIEW

The company operates in 10 major markets.  At December 31, 1997, the company did
not own more  than  22% of its  apartment  communities  in any one  market.  The
following table summarizes the company's major apartment market information.

<TABLE>
<CAPTION>
                       Number of                       Percent       Average        December
                       Apartment                      of Total      Economic         Monthly
Market                Communities              Cost Apartments     Occupancy     Rental Rate
----------------------------------------------------------------------------------------------
<S>                            <C>    <C>                   <C>        <C>              <C>
Raleigh/Durham, NC             11     $ 108,274,356         22%        93.8%            $ 660
Charlotte, NC                   9        97,118,486         20         92.2               572
Atlanta,GA                      4        55,470,782         11         89.9               673
Richmond, VA                    3        37,947,312          8         95.8               585
Virginia Beach, VA              5        37,261,274          8         93.2               604
Greenville, SC                  3        20,550,884          4         90.7               446
Augusta, GA                     2        18,557,664          4         84.8               466
Winston-Salem, NC               2        18,259,348          4         92.7               597
Wilmington, NC                  3        17,478,738          4         92.2               565
Columbia, SC                    2        16,952,243          3         91.8               572
Other                           7        59,704,109         12         93.6               533
---------------------------------------------------------------------------------------------
Total                          51     $ 487,575,196        100%        91.9%            $ 582
=============================================================================================
</TABLE>

     The  following  discussion  is based  on the  financial  statements  of the
company as of December 31, 1997, 1996 and 1995. This information  should be read
in conjunction with the selected  financial data and the company's  consolidated
financial  statements  included  elsewhere in this annual report. The company is
operated and has elected to be treated as a real estate  investment trust (REIT)
for federal income tax purposes.

     This annual report contains  forward-looking  statements within the meaning
of Section 27A of the Securities Act of 1993, as amended, and Section 21E of the
Securities  Exchange Act of 1934, as amended.  Such  forward-looking  statements
include,  without limitation,  statements concerning  anticipated lower expenses
from the company's conversion to self-administration,  anticipated  improvements
in financial  operations from completed and planned  property  renovations,  and
expected  benefits  from the company's  ownership of stock in Apple  Residential
Income Trust, Inc. (Apple) and the acquisition, advisory and property management
services  provided to Apple.  Such  statements  involve known and unknown risks,
uncertainties and other factors which may cause the actual results,  performance
or  achievement  of the company to be materially  different  from the results of
operations  or plans  expressed or implied by such  forward-looking  statements.
Such  factors  include,  among  other  things,  unanticipated  adverse  business
developments affecting the company, the properties or Apple, as the case may be,
adverse  changes in the real estate markets and general and local  economies and
business  conditions.   Although  the  company  believes  that  the  assumptions
underlying the forward-looking  statements contained herein are reasonable,  any
of the assumptions could be inaccurate,  and therefore there can be no assurance
that such  statements  included in this annual report will prove to be accurate.
In  light  of the  significant  uncertainties  inherent  in the  forward-looking
statements  included  herein,  the inclusion of such  information  should not be
regarded as a representation by the company or any other person that the results
or conditions  described in such  statements or the  objectives and plans of the
company will be achieved.

RESULTS  OF  OPERATIONS  COMPARISON  OF  THE YEAR  ENDED  DECEMBER  31,  1997 TO
DECEMBER 31, 1996

CONVERSION TO SELF-ADMINISTRATION

Effective  October 1, 1996, the company  agreed with its affiliated  advisor and
management  companies  on a series of  transactions,  the effect of which was to
convert the company into a  "self-administered"  and  "self-managed"  REIT.  The
transactions were unanimously approved by the Board of Directors of the company.
The  conversion was approved  because it is expected to reduce future  operating
expenses  compared  to what  those  expenses  would  have been  under the former
"externally managed and advised"  arrangements.  The net effect of these savings
on earnings  basic and diluted per share is partially  offset by the issuance of
common shares to effect the transaction as described below.

                                      -22-

<PAGE>

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

     Pursuant to this  conversion,  the company agreed to issue 1,400,000 common
shares,  with 700,000 shares issued in October 1996 and 700,000 shares issued on
September 30, 1997, and paid  approximately  $1,913,000 to the various  entities
for several assets and various contracts.  This transaction was accounted for as
the  termination  of  management   contracts  and  resulted  in  an  expense  of
$16,526,012 in 1996 and $402,907 in 1997. This expense was the primary factor in
the company's net loss of $4,169,849 ($.21 per share) for 1996 versus net income
of  $19,225,553  ($.59  per  share)  in  1997  (See  Note 6 to the  consolidated
financial statements).

     All earnings per share amounts  presented  have been restated to conform to
the Financial  Accounting  Standards No. 128 "Earnings Per Share" (See Note 1 to
the consolidated financial statements).

INCOME AND OCCUPANCY

     The  results  of the  company's  property  operations  for the  year  ended
December  31,  1997  include  the  results  of  operations   from  the  pre-1997
acquisitions  and from the 13 properties  acquired in 1997 from their respective
acquisition dates. The company portfolio  consisted of 51 properties at December
31, 1997. The increased rental income and operating  expenses for the year ended
December 31, 1997,  over the year ended December 31, 1996, is primarily due to a
full  year  of  operation  in  1997  of the  1996  acquisitions  as  well as the
incremental effect of the 1997 acquisitions.

     Substantially  all of the company's revenue is from the rental operation of
its apartment  communities.  Rental income  increased 74% to $70,115,678 in 1997
from $40,261,674 in 1996 due to the factors  described  above.  Rental income is
expected to continue to increase from the impact of planned improvements,  which
are being made in an effort to improve the properties'  marketability,  economic
occupancies and rental rates.

     Overall average economic  occupancy was 92% in 1997 and 91% in 1996. Rental
rates for the  portfolio  increased 6% to $582 on December 31, 1997 from $549 on
December 31, 1996.  This  increase is due to a combination  of increased  rental
rates from new leases and property  renovation and the acquisition of properties
with higher average rental rates.  The properties  acquired prior to 1997 had an
average  economic  occupancy of 93% during 1997 and 91% during 1996.

COMPARABLE PROPERTY RESULTS

On a  comparative  basis,  the 19  properties  owned during all of 1997 and 1996
provided   rental  and  operating   income  of  $27,476,460   and   $16,566,239,
respectively,  in 1997 and $25,508,627 and $14,587,654,  respectively,  in 1996.
This  represents an increase from 1996 to 1997 of 7.7% and 13.6%,  respectively.
The conversion to  "self-administration"  took place in October 1996. Therefore,
the  actual  results  for  property  operations  contained  a  partial  year  of
management  fees in 1996. In order to make a meaningful  comparison of operating
income for these properties between 1996 and 1997,  property  management expense
was  eliminated  in  1996.  This  adjustment   allows  for  a  comparison  on  a
"self-administered"  and  "self-managed"  basis.  As  adjusted,  the  properties
provided  operating  income of $15,429,270 in 1996. This represents an operating
increase of 7.4%. The eliminated  expenses included property management fees and
expenses of $841,616 in 1996.

EXPENSES

Total property expenses,  excluding management contract  termination,  increased
69% to $45,111,959 in 1997 from $26,764,844 in 1996, due largely to the increase
in the number of apartments. The operating expense ratio (the ratio of operating
expenses, excluding depreciation and amortization,  to rental income) was 40% in
1997 and 43% in 1996. The decline in the operating expense ratio is attributable
to the  conversion  of the  company to  "self-administered"  and  "self-managed"
status  and  increasing  economies  of  scale  based  on the  company's  growing
portfolio of properties.

     General and  administrative  expenses  totaled 1.9% of revenues in 1997 and
3.2% in 1996.  These  expenses  represent  the  administrative  expenses  of the
company as  distinguished  from the operations of the company's  properties.  In
1997,   the  company  has  continued  to  expand  its  internal   administrative
infrastructure to keep pace with its growth.

     Depreciation  of  real  estate   increased  to  $15,163,593  in  1997  from
$8,068,063  in  1996,  and  is  directly  attributable  to  the  acquisition  of
additional  apartment  communities  in 1996 and 1997.


                                      -23-

<PAGE>

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

INTEREST AND INVESTMENT INCOME AND EXPENSE

The company earned  interest income of $77,942 in 1997 and $287,344 in 1996 from
the  investment  of its cash  and  cash  reserves.  The  decrease  is due to the
company's cash management  policy of paying down on the unsecured line of credit
which  incurred  a higher  rate of  interest  than what the  company  would have
earned.  The company  incurred  $7,006,182 and $1,272,530 of interest expense in
1997 and 1996,  respectively,  associated with short-term  borrowings  under its
line of credit.  This is a result of the  increased use of its line of credit to
fund  acquisitions.  The weighted  average  interest  rate on the line of credit
during 1997 and 1996 was 7.2%.


INCOME AND EXPENSE FROM RELATIONSHIP WITH APPLE RESIDENTIAL INCOME TRUST

Property management fees are 5% of monthly gross revenues. Advisory fees are .1%
to .25% of total  capital  raised by Apple.  The company  received  $822,934 for
advisory and property  management  services.  The company received $1,031,066 in
real estate  commissions under separate  contract and amortized  $546,000 of the
purchase price of this  contract.  The real estate  commissions  equal 2% of the
purchase  price  of  the  properties   Apple  acquires.   The  company  incurred
approximately  $355,928 in related expenses.  Dividend income from the company's
investment  in  Apple  was  $253,172  in  1997.(See  Note 6 to the  consolidated
financial statements).

RESULTS  OF  OPERATIONS  COMPARISON  OF  THE YEAR  ENDED  DECEMBER  31,  1996 TO
DECEMBER 31, 1995

CHANGES IN ACCOUNTING POLICIES

During the first quarter of 1996, the company adopted the provisions of FASB No.
121  "Accounting  for the  Impairment  of Long-Lived  Assets and for  Long-Lived
Assets to be Disposed Of." The adoption of this statement did not have an impact
on the company's financial statements (See Note 1 to the consolidated  financial
statements).

INCOME AND OCCUPANCY

The company had increased rental income and operating expenses in 1996 from 1995
due to the full year of operations  from the pre-1996  acquisitions  and from 21
properties  acquired in 1996 from their  respective  acquisition  dates.  Rental
income in 1996  increased  148% to  $40,261,674,  from  $16,266,610 in 1995. The
properties had an average economic occupancy of 91% during 1996 and 92% in 1995.

COMPARABLE PROPERTY RESULTS

On a comparative  basis,  the nine properties  owned during all of 1996 and 1995
provided   rental  and  operating   income  of   $12,546,624   and   $7,082,130,
respectively,  in 1996; and  $11,644,096 and $6,226,341 in 1995. This represents
an  increase  from  1995 to 1996 of 7.9%  and  13.7%,  respectively.  Since  the
conversion to "self-management"  took place in October 1996, property management
expenses need to be eliminated for the full 1995 year and a partial 1996 year in
order to make a meaningful  comparison of operating  income for these properties
between  1995  and  1996.  This   adjustment   allows  for  a  comparison  on  a
"self-administered"  and  "self-managed"  basis.  As  adjusted,  the  properties
provided  operating  income of $7,537,707 in 1996 and  $6,928,227 in 1995.  This
represents  an operating  increase of 8.8%.  The  eliminated  expenses  included
property  management fees of $535,471 in 1995 and $414,505 in 1996. In addition,
expenses  related to the property  management  contracts of $148,322 in 1995 and
$41,072 in 1996 were eliminated.

     Overall,  rental rates for the portfolio increased 9.8% to $549 at December
31, 1996 from $500 at December 31, 1995.  This increase was due to a combination
of  increased  rental  rates  from new leases and  property  renovation  and the
acquisition  of properties  with higher  average  rental rates.

EXPENSES

Total property expenses,  excluding  management contract  termination  expenses,
increased 144% to  $26,764,844  in 1996 from  $10,968,834 in 1995 due largely to
the increased  number of apartments.  The operating  expense ratio (the ratio of
operating  expenses to rental income) was 43% in 1996 and 46% for 1995.  General
and  administrative  expenses totaled 3.2% of revenues in 1996 and 3.7% in

                                      -24-

<PAGE>

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

1995. This decrease in percentage is attributed to efficiency  achieved  through
economies of scale.  Depreciation of real estate increased to $8,068,063 in 1996
from  $2,788,818  in 1995,  and is directly  attributed  to the  acquisition  of
apartment  communities  in 1995  and  1996 and a full  year of  depreciation  of
properties  acquired in 1995.

INTEREST INCOME AND EXPENSE

Interest income was $287,344 in 1996 and $226,555 in 1995. The company  incurred
$1,272,530  and  $292,103  of interest  expense in 1996 and 1995,  respectively,
associated with short-term borrowings under its line of credit.

LIQUIDITY AND CAPITAL RESOURCES

EQUITY

There was a significant change in the company's  liquidity during the year ended
December  31, 1997 as the company  continued to grow.  During 1997,  the company
completed  an  additional   public  offering  of  5,175,000   common  shares  in
conjunction  with the  listing of the  company's  common  shares on the New York
Stock  Exchange.  The total gross  proceeds  from the offering was  $54,337,500,
which  netted  $49,287,000  to the  company  after the  payment of  underwriting
discounts and commissions.

     Using the acquisition line of credit,  the company acquired 2,889 apartment
units in 13 residential  rental  communities  during 1997.  During the year, two
properties  were  combined  and are now  operated  as one,  and one of the  1997
acquisitions  became an extension of an existing  property.  These  acquisitions
brought the total number of residential  rental  communities to 51 and the total
apartment units owned at year-end to 11,922.

     The company has a shelf  registration  in effect which was filed on January
27, 1998 (which  amended the original  dated August 27, 1996) for $200  million.
The proceeds will be used by the company for general corporate  purposes.

NOTES PAYABLE

The company intends to acquire additional  properties and may seek to fund these
acquisitions  through a combination of equity offerings and unsecured  corporate
debt. To meet this objective, the company obtained a $175 million unsecured line
of credit with a consortium of six banks.  The line expires on October 30, 2000.
The line currently  bears interest at the LIBOR rate plus 120 basis points.  The
company  anticipates  curtailing  the line of credit with the proceeds of future
offerings of common shares.

     At year-end,  the company had an outstanding balance of $144 million on the
acquisition  line of credit and $2.5  million on its general  corporate  line of
credit.  In addition,  the company had outstanding a $5.5 million unsecured note
bearing an effective interest rate of 6.65% per annum. This debt is to a private
lender and is due in June 1999.

     In January 1998,  the company  acquired Stone Point  Apartments,  (formerly
Sterling Pointe),  a 192-unit  apartment  community located in Charlotte,  North
Carolina,  for $9.7 million.  The company used its  unsecured  line of credit to
effect this acquisition.  The company has approximately $22 million of currently
available borrowing capacity for future  acquisitions.

CAPITAL REQUIREMENTS

The company has an ongoing capital expenditure commitment to fund its renovation
program for recently acquired  properties.  In addition,  the company expects to
acquire new  properties  during the year. The company  anticipates  that it will
continue  to  operate as it did in 1997 and fund these cash needs from a variety
of sources  including  equity,  cash  reserves and debt  provided by its line of
credit.

     The company continues to renovate its properties.  In connection with these
renovations,  the  company  capitalized  improvements  of $23  million  in 1997.
Approximately  $12 million of additional  capital  improvements are budgeted for
1998 on the existing property  portfolio which are expected to be funded through
cash reserves and dividend reinvestment.

     The  company  has  short-term  cash  flow  needs in order  to  conduct  the
operation of its  properties.  The rental income  generated  from the properties
supplies ample cash to provide for the payment of these  operating  expenses and
the payment of distributions.

                                      -25-

<PAGE>

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

     Capital  resources  are expected to grow with the future sale of its shares
and from cash flow from operations. Approximately 45% of all 1997 distributions,
$14,198,868,  were  reinvested  in additional  common  shares.  In general,  the
company's  liquidity and capital resources are believed to be more than adequate
to meet its cash requirements during 1998.

     The  company is  operated  as, and  annually  elects to be taxed as, a real
estate  investment  trust under the  Internal  Revenue  Code.  As a result,  the
company has no provision  for taxes and thus there is no effect on the company's
liquidity from taxes.

APPLE RESIDENTIAL INCOME TRUST

As of December 31, 1997, the company owned 417,778 common shares of Apple. These
shares  represent  approximately  3% of common  shares of Apple  outstanding  at
December 31, 1997. In 1997,  Apple granted the company a continuing right to own
up to 9.8% of the  common  shares of Apple at the market  price,  net of selling
commissions.  Apple also has  granted  the  company a first  right of refusal to
purchase the business or  properties of Apple.  (See Note 6 to the  consolidated
financial  statements).

IMPACT OF YEAR 2000

Some computer  programs were written using two digits rather than four to define
the applicable year. As a result,  those computer  programs have  time-sensitive
software that  recognize a date using "00" as the year 1900 rather than the year
2000.  This  could  cause  a  system   miscalculation   causing  disruptions  of
operations.  The company has  completed  an  assessment  of its programs and has
begun to modify or replace portions of its software so that its computer systems
will function  properly  with respect to dates in the year 2000 and  thereafter.
The total  Year  2000  project  cost will be  expensed  as  incurred  and is not
expected to have a material effect on the company's results of operations.  This
project is estimated to be completed by December 31, 1998, which is prior to any
impact on the company's system.

IMPACT OF INFLATION

     The company does not believe that inflation had any  significant  impact on
its operation in 1997.  Future  inflation,  if any, would likely cause increased
operating expenses, but the company believes that increases in expenses would be
more than offset by increases in rental revenues.  Continued  inflation may also
cause  capital  appreciation  of the company's  properties  over time, as rental
rates and replacement costs increase.

                                      -26-

<PAGE>



INDEPENDENT AUDITORS' REPORT

THE BOARD OF DIRECTORS AND SHAREHOLDERS
CORNERSTONE REALTY INCOME TRUST, INC.

We have audited the  accompanying  consolidated  balance  sheets of  Cornerstone
Realty Income Trust,  Inc. (the "Company") as of December 31, 1997 and 1996, and
the related  consolidated  statements of operations,  shareholders'  equity, and
cash flows for each of the three years in the period  ended  December  31, 1997.
These financial  statements are the responsibility of the Company's  management.
Our responsibility is to express an opinion on these financial  statements based
on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material respects,  the financial position of Cornerstone
Realty Income Trust,  Inc. at December 31, 1997 and 1996,  and the  consolidated
results of its  operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.

     As discussed in Note 1 to the consolidated  financial  statements,  in 1996
the company changed its method of accounting for impairment of long-lived assets
and long-lived assets held for disposition.


                                                       /s/ Ernst & Young LLP

Richmond, Virginia
January 22, 1998



                                      -27-

<PAGE>



CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                          As of December 31,
------------------------------------------------------------------------------------------------
                                                                        1997              1996
                                                                ------------      ------------
<S>                                                             <C>               <C>
ASSETS
Investment in rental property
   Land                                                         $ 76,812,953      $ 46,980,280
   Building and improvements                                     402,545,094       277,345,752
   Furniture and fixtures                                          8,217,149         5,389,821
                                                                ------------      ------------
                                                                 487,575,196       329,715,853
Less accumulated depreciation                                    (27,486,630)      (12,323,037)
                                                                ------------      ------------
                                                                 460,088,566       317,392,816
                                                                ------------      ------------
Cash and cash equivalents                                          4,513,986         3,182,651
Prepaid expenses                                                     797,484           557,544
Other assets                                                       8,786,414         1,737,563
                                                                ------------      ------------
                                                                  14,097,884         5,477,758
                                                                ------------      ------------
   Total Assets                                                 $474,186,450      $322,870,574
                                                                ============      ============
LIABILITIES AND SHAREHOLDERS' EQUITY

Notes payable                                                   $151,569,147      $ 55,403,000
Accrued payable-related party                                             --         7,297,093
Accounts payable                                                   3,812,578         2,087,673
Accrued expenses                                                   1,158,014         1,366,853
Rents received in advance                                            463,997           491,928
Tenant security deposits                                           1,854,462         1,654,322
                                                                ------------      ------------
   Total Liabilities                                             158,858,198        68,300,869
Shareholders' equity
Common stock, no par value; authorized 50,000,000
   shares; issued and outstanding 35,510,327 shares
   and 28,141,509 shares, respectively                           349,135,379       276,269,539
Deferred compensation                                                (62,976)          (55,000)
Distributions greater than net income                            (33,744,151)      (21,644,834)
                                                                ------------      ------------
                                                                 315,328,252       254,569,705
                                                                ------------      ------------
   Total Liabilities and Shareholders' Equity                   $474,186,450      $322,870,574
                                                                ============      ============
</TABLE>


See accompanying notes to financial statements.

                                      -28-

<PAGE>





CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                       Years Ended December 31,
------------------------------------------------------------------------------------------------
                                                          1997            1996            1995
                                                  ------------    ------------    ------------
<S>                                               <C>             <C>             <C>
REVENUE

   Rental income                                  $ 70,115,678    $ 40,261,674    $ 16,266,610
   Other income                                      1,854,946              --              --
EXPENSES

   Property and maintenance                         19,494,692      11,406,042       5,178,075
   Taxes and insurance                               6,075,991       3,275,422       1,201,812
   Property management fee                                  --       1,243,215         896,521
   Property management                               1,769,272       1,274,203         181,166
   General and administrative                        1,351,667       1,298,970         609,969
   Amortization expense and other depreciation          56,075          47,133          30,564
   Depreciation of rental property                  15,163,593       8,068,063       2,788,818
   Other                                             1,200,669         151,796          81,909
   Management contract termination                     402,907      16,526,012              --
                                                  ------------    ------------    ------------
Total expenses                                      45,514,866      43,290,856      10,968,834
                                                  ------------    ------------    ------------
Income (loss) before interest income (expense)      26,455,758      (3,029,182)      5,297,776
   Interest income                                     331,114         287,344         226,555
   Interest expense                                 (7,561,319)     (1,428,011)       (294,616)
                                                  ------------    ------------    ------------
Net income (loss)                                 $ 19,225,553    $ (4,169,849)   $  5,229,715
                                                  ============    ============    ============
Basic and diluted earnings (loss) per common
 share                                            $       0.59    $      (0.21)   $       0.64
                                                  ============    ============    ============
</TABLE>


See accompanying notes to financial statements.

                                      -29-

<PAGE>



CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY


<TABLE>
<CAPTION>

                                            Common Stock                         Distributions
                                      --------------------                         (Greater)       Total
                                        Number                      Deferred       Less Than    Shareholders'
                                      of Shares      Amount       Compensation     Net Income      Equity
--------------------------------------------------------------------------------------------------------------
<S>                                   <C>        <C>              <C>           <C>             <C>
BALANCE AT DECEMBER 31, 1994          5,458,648  $  51,890,477    $       --    $     (453,614) $  51,436,863
Net proceeds from the sale of shares  6,930,567     68,255,383            --                --     68,255,383
Net income                                   --             --            --         5,229,715      5,229,715
Cash distributions declared to
   shareholders ($.9575 per share)           --             --            --        (6,316,185)    (6,316,185)
Restricted stock grants                  10,000        110,000      (110,000)               --             --
Amortization of deferred compensation        --             --        33,000                --         33,000
Shares issued through
   reinvestment of distributions        355,116      3,515,644            --                --      3,515,644
                                     -------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995         12,754,331    123,771,504       (77,000)       (1,540,084)   122,154,420
Net proceeds from the sale of shares 13,816,973    136,183,048            --                --    136,183,048
Net loss                                     --             --            --        (4,169,849)    (4,169,849)
Cash distributions declared to
   shareholders ($.9930 per share)           --             --            --       (15,934,901)   (15,934,901)
Shares issued in connection with
   management contract termination      700,000      7,700,000            --                --      7,700,000
Amortization of deferred compensation        --             --        22,000                --         22,000
Shares issued through reinvestment
   of distributions                     870,205      8,614,987            --                --      8,614,987
                                     -------------------------------------------------------------------------

BALANCE AT DECEMBER 31, 1996         28,141,509    276,269,539       (55,000)      (21,644,834)   254,569,705
Net proceeds from the sale of shares  5,175,000     49,287,000            --                --     49,287,000
Net income                                   --             --            --        19,225,553     19,225,553
Cash distributions declared to
   shareholders ($1.00 per share)            --             --            --       (31,324,870)   (31,324,870)
Restricted stock grant                    2,772         29,972       (29,972)               --             --
Shares issued for purchase of
   Apple Realty Group, Inc. contracts   150,000      1,650,000            --                --      1,650,000
Shares issued in connection with
   management contract termination      700,000      7,700,000            --                --      7,700,000
Amortization of deferred compensation        --             --        21,996                --         21,996
Shares issued through reinvestment
   of distributions                   1,341,046     14,198,868            --                --     14,198,868
                                     -------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997         35,510,327  $ 349,135,379    $  (62,976)   $  (33,744,151) $ 315,328,252
                                     =========================================================================
</TABLE>


See accompanying notes to financial statements.

                                      -30-

<PAGE>



CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                                                          1997            1996            1995
                                                  ------------------------------------------------
<S>                                                <C>             <C>            <C>
FROM OPERATING ACTIVITIES:
   Net income (loss)                               $ 19,225,553    $ (4,169,849)  $  5,229,715
   Adjustments to reconcile net income (loss) to
      net cash provided by operating activities:
      Depreciation and amortization                  15,219,668       8,115,196      2,819,382
      Amortization of deferred compensation              21,996          22,000         33,000
      Amortization of deferred financing costs          212,802          91,592         43,983
      Management contract termination                   402,907      14,997,093             --
      Amortization of Apple Realty Group, Inc.
        contract                                        546,000              --             --
   Changes in operating assets and liabilities:
      Prepaid expenses                                 (239,940)       (390,392)       (63,594)
      Other assets                                   (2,103,728)     (1,377,028)      (349,055)
      Accounts payable                                1,724,905       1,531,982        342,293
      Accrued expenses                                 (208,839)        109,622      1,026,414
      Rent received in advance                          (27,931)        362,280         63,511
      Tenant security deposits                          200,140         870,280        473,307
                                                   -----------------------------------------------
         Net cash provided by operating
          activities                                 34,973,533      20,162,776      9,618,956
FROM INVESTING ACTIVITIES:
   Acquisitions of rental property,
      net of debt assumed                          (134,900,712)   (175,471,367)   (68,482,525)
   Capital improvements                             (22,958,631)    (19,048,039)    (7,106,564)
   Investment in Apple Residential
      Income Trust, Inc.                             (3,760,000)             --             --
   Purchase of acquisition/disposition contract
      from Apple Realty Group, Inc.                    (350,000)             --             --
                                                   -----------------------------------------------
          Net cash used in investing activities    (161,969,343)   (194,519,406)   (75,589,089)
FROM FINANCING ACTIVITIES:
   Proceeds from short-term borrowings              442,927,152     135,653,144     38,300,000
   Repayments of short-term borrowings             (346,761,005)    (94,050,144)   (35,000,000)
   Net proceeds from issuance of shares              63,485,868     144,798,035     71,771,027
   Cash distributions paid to shareholders          (31,324,870)    (15,934,901)    (6,316,185)
                                                   -----------------------------------------------
          Net cash provided by financing
           activities                               128,327,145     170,466,134     68,754,842
          Increase (decrease) in cash and
             cash equivalents                         1,331,335      (3,890,496)     2,784,709
Cash and cash equivalents, beginning of year          3,182,651       7,073,147      4,288,438
                                                   -----------------------------------------------
Cash and cash equivalents, end of year             $  4,513,986    $  3,182,651   $  7,073,147
                                                   ===============================================
</TABLE>



See accompanying notes to financial statements.

                                      -31-

<PAGE>

NOTE TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1
GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS AND BASIS OF PRESENTATION

Cornerstone  Realty  Income  Trust,  Inc.  (together  with its  subsidiary,  the
"company"),  a  Virginia  corporation,   is  an  owner-operator  of  residential
apartment communities in the mid-Atlantic and southeastern regions of the United
States. The accompanying  consolidated financial statements include the accounts
of the  company  along with its  wholly  owned  subsidiary,  CRIT-NC,  LLC.  All
significant  inter-company  accounts and  transactions  have been  eliminated in
consolidation.  The company's common shares trade on the New York Stock Exchange
under the ticker symbol TCR.

     Certain  previously  reported amounts have been  reclassified to conform to
the current year presentation.

CASH AND CASH EQUIVALENTS

Cash equivalents  include highly liquid investments with original  maturities of
three  months  or less.  The  fair  market  value  of cash and cash  equivalents
approximate their carrying value.

INVESTMENT IN RENTAL PROPERTY

In  1996,  the  company  adopted  FASB  Statement  No.121,  "Accounting  for the
Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed Of."
The company records  impairment  losses on rental property used in operations if
indicators of impairment are present and the  undiscounted  cash flows estimated
to be  generated  by the  respective  properties  are less than  their  carrying
amount.  Impairment  losses are measured as the  difference  between the asset's
fair value,  less cost to sell,  and its  carrying  value.  The adoption of this
Statement did not have an impact on the company's financial statements.

     The investment in rental  property is recorded at the lower of cost or fair
value and includes real estate brokerage  commissions paid to Cornerstone Realty
Group,  a related party,  for purchases  prior to October 1, 1996 (See Note 6 to
the consolidated financial statements).

     Repairs and  maintenance  costs are expensed as incurred while  significant
improvements,  renovations and  replacements  are  capitalized.  Depreciation is
computed on a straight-line basis over the estimated useful lives of the related
assets which are 27.5 years for  buildings  and major  improvements  and a range
from five to seven years for furniture and fixtures.

INCOME RECOGNITION

Rental,  interest  and other  income  are  recorded  on an  accrual  basis.  The
company's  properties are leased under operating  leases that,  typically,  have
terms that do not exceed one year.

USE OF ESTIMATES

The preparation of financial  statements in accordance  with generally  accepted
accounting   principles  requires  management  to  make  certain  estimates  and
assumptions  that  affect  amounts  reported  in the  financial  statements  and
accompanying  notes.  Actual  results  may differ  from those  estimates.

STOCK INCENTIVE PLANS

The  company  elected to follow  Accounting  Principles  Board  Opinion  No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related  interpretations
in  accounting  for its  employee  stock  options.  As  discussed in Note 5, the
alternative  fair value  accounting  provided for under FASB  Statement No. 123,
"Accounting  for  Stock-Based  Compensation,"  ("FASB 123")  requires the use of
option  valuation  models that were not  developed  for use in valuing  employee
stock  options.  Under  APB 25,  because  the  exercise  price of the  company's
employee stock options  equals the market price of the  underlying  stock on the
date of grant, no compensation  expense is recognized.

ADVERTISING COSTS

Costs incurred for the production and  distribution  of advertising are expensed
as incurred.

INCOME PER SHARE

In 1997,  the Financial  Accounting  Standards  Board issued  Statement No. 128,
"Earnings  per Share."  Statement  128 replaced the  calculation  of primary and
fully  diluted  earnings  per share with basic and diluted  earnings  per share.
Unlike  primary  earnings  per share,  basic  earnings  per share  excludes  any
dilutive  effects of options,  warrants,  and  convertible  securities.  Diluted
earnings  per share is very similar to the  previously  reported  fully  diluted
earnings per share.  All  earnings  per share  amounts for all periods have been
presented,  and where  appropriate,  restated  to conform to the  Statement  128
requirements.

                                      -32-

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEDERAL INCOME TAXES

The company is operated  as, and  annually  elects to be taxed as, a real estate
investment  trust  under the  Internal  Revenue  Code of 1986,  as amended  (the
"Code").  Generally,  a real estate  investment  trust which  complies  with the
provisions of the Code and distributes at least 95% of its taxable income to its
shareholders  does  not pay  federal  income  taxes on its  distributed  income.
Accordingly, no provision has been made for federal income taxes.

     For income tax  purposes,  distributions  paid to  shareholders  consist of
ordinary  income and return of capital or a combination  thereof.  Distributions
per share were $1.00,  $.993,  and $.9575 in the years ended  December 31, 1997,
1996 and 1995, respectively. In 1997, of the total distribution, 77% was taxable
as ordinary income and 23% was a non-taxable return of capital.  In 1996, of the
total distribution, 86% was taxable as ordinary income and 14% was a non-taxable
return of capital.  In 1995,  83% was  taxable as ordinary  income and 17% was a
non-taxable return of capital.

NOTE 2
INVESTMENT IN RENTAL PROPERTY

The following is a summary of rental property owned at December 31, 1997.

<TABLE>
<CAPTION>
                                 Initial              Total       Accumulated             Date
Description              Acquisition Cost        Investment*     Depreciation         Acquired
------------------------------------------------------------------------------------------------
<S>                          <C>               <C>               <C>                      <C>
NORTH CAROLINA
Raleigh/Durham, North Carolina
The Hollows                  $  4,200,000      $  5,862,730      $    803,937        June 1993
The Trestles                   10,350,000        11,345,191         1,109,837    December 1994
The Landing                     8,345,000         9,827,290           532,052         May 1996
Highland Hills                 12,100,000        13,901,839           656,581   September 1996
Parkside at Woodlake           14,663,886        14,929,908           619,610   September 1996
Deerfield                      10,675,000        11,095,295           456,364    November 1996
Paces Arbor                     5,588,219         5,836,534           142,901       March 1997
Paces Forest                    6,473,481         6,793,400           167,343       March 1997
Clarion Crossing               10,600,000        10,812,429            92,074   September 1997
St. Regis                       9,800,000         9,887,449            46,995     October 1997
Remington  Place                7,900,000         7,982,291            39,791     October 1997
Charlotte, North Carolina
Hanover Landing                 5,725,000         7,264,857           550,759      August 1995
Sailboat Bay                    9,100,000        13,198,131         1,132,932    November 1995
Bridgetown Bay                  5,025,000         5,763,770           340,018       April 1996
Meadow Creek                   11,100,000        12,295,434           692,927         May 1996
Beacon Hill                    13,579,203        14,517,795           705,777         May 1996
Summerwalk                      5,660,000         7,139,674           338,188         May 1996
Paces Glen                      7,425,000         8,027,477           317,033        July 1996
Heatherwood                    17,630,457        18,903,942           507,135               **
Charleston Place                9,475,000        10,007,406           211,614         May 1997
Winston-Salem, North Carolina
Mill Creek                      8,550,000         9,395,861           677,900   September 1995
Glen Eagles                     7,300,000         8,863,487           627,144     October 1995
Wilmington, North Carolina
Wimbledon Chase                 3,300,000         5,461,662           767,403    February 1994
Chase Mooring                   3,594,000         5,174,122           617,969      August 1994
Osprey Landing                  4,375,000         6,842,954           510,604    November 1995
Other North Carolina
Wind Lake                       8,760,000         9,817,050           899,238       April 1995
The Meadows                     6,200,000         7,460,262           536,888     January 1996
Signature Place                 5,462,948         6,727,435           340,582      August 1996
GEORGIA
Atlanta, Georgia
Ashley Run                     18,000,000        18,684,443           410,263       April 1997
Carlyle Club                   11,580,000        12,237,864           242,599       April 1997
Dunwoody Springs               15,200,000        16,594,594           227,872        July 1997
Stone Brooke                    7,850,000         7,953,881            38,965     October 1997
Augusta, Georgia
West Eagle Greens               4,020,000         6,056,355           394,366       March 1996
Savannah West                   9,843,620        12,501,309           626,284        July 1996
</TABLE>

                                      -33-

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 CONTINUED
INVESTMENT IN RENTAL PROPERTY

<TABLE>
<CAPTION>
                                 Initial              Total       Accumulated             Date
Description              Acquisition Cost        Investment*     Depreciation         Acquired
-------------------------------------------------------------------------------------------------
<S>                            <C>               <C>                  <C>                <C>
VIRGINIA
Richmond, Virginia
Ashley Park                    12,205,000        12,942,802           823,302       March 1996
Trolley Square                 10,242,575        12,547,009           523,667              ***
Hampton Glen                   11,599,931        12,457,501           591,866      August 1996
Virginia Beach, Virginia
Mayflower Seaside               7,634,144         9,517,913         1,103,186     October 1993
Harbour Club                    5,250,000         6,104,145           682,749         May 1994
Bay Watch Pointe                3,372,525         4,881,908           408,201        July 1995
Tradewinds                     10,200,000        10,889,492           811,294    November 1995
Arbor Trace                     5,000,000         5,867,816           336,766       March 1996
Other Virginia
County Green                    3,800,000         5,203,820           777,966    December 1993
Trophy Chase                    3,710,000         6,481,964           367,546       April 1996
Greenbrier                     11,099,525        11,813,814           506,348     October 1996
SOUTH CAROLINA
Greenville, South Carolina
Polo Club                       4,300,000         6,904,635         1,348,765        June 1993
Breckinridge                    5,600,000         6,896,124           517,880        June 1995
Magnolia Run                    5,500,000         6,750,125           633,948        June 1995
Columbia, South Carolina
Stone Ridge                     3,325,000         5,612,592           910,979    December 1993
The Arbors at Windsor Lake     10,875,000        11,339,651           388,602     January 1997
Other South Carolina
Westchase                      11,000,000        12,199,764           371,620     January 1997
-------------------------------------------------------------------------------------------------
                             $424,164,514      $487,575,196      $ 27,486,630
</TABLE>

* Includes real estate commissions,  closing costs and improvements  capitalized
since the date of acquisition.

** Heatherwood  Apartments is comprised of Heatherwood and Italian Village/Villa
Marina Apartments,  acquired in September 1996 and August 1997, respectively, at
a cost of  $10,205,457  and  $7,425,000.  They are adjoining  properties and are
operated as one apartment community.

*** Trolley  Square  Apartments is comprised of Trolley  Square East and Trolley
Square West Apartments acquired in June 1996 and December 1996, respectively, at
a cost of  $6,000,000  and  $4,242,575.  They are  adjacent  properties  and are
operated as one apartment community.

The following is a reconciliation of the carrying amount of real estate owned:

<TABLE>
<CAPTION>
                                                   1997               1996              1995
----------------------------------------------------------------------------------------------
<S>                <C>                     <C>                <C>               <C>
Balance at January 1                       $329,715,853       $129,696,447      $  54,107,358
Real estate purchased                       134,900,712        180,971,367         68,482,525
Improvements, furniture and fixtures         22,958,631         19,048,039          7,106,564
=============================================================================================
Balance at December 31                     $487,575,196       $329,715,853       $129,696,447
</TABLE>

The following is a reconciliation of accumulated depreciation:

<TABLE>
<CAPTION>
                                                   1997               1996               1995
----------------------------------------------------------------------------------------------
<S>                <C>                     <C>                <C>               <C>
Balance at January 1                       $ 12,323,037       $  4,254,974      $   1,466,156
Depreciation expense                         15,163,593           8,068,063          2,788,818
----------------------------------------------------------------------------------------------
Balance at December 31                     $ 27,486,630       $ 12,323,037      $   4,254,974
</TABLE>

NOTE 3
NOTES PAYABLE

During 1997, the company obtained a $175 million unsecured line of credit with a
consortium  of six banks  which  replaced  its $100  million  unsecured  line of
credit.  The new line of credit bears interest at one month LIBOR plus 120 basis
points at December 31, 1997.  The previous  line of credit bore  interest at one
month LIBOR plus 160 basis points at December 31, 1996. In addition, the company
is  obligated  to pay the lenders a quarterly  commitment  fee equal to .20% per
annum of the unused  portion of the line.  The entire  balance is due on October
30,  2000.  At December  31,  1997,  borrowings  under the  agreement  were $144
million.  The weighted average interest rates incurred under the lines of credit
were 7.2% in 1997, 7.2% in 1996 and 7.8% in 1995.

     The line of credit agreement  contains certain covenants which, among other
things,   require   maintenance  of  certain   financial   ratios  and  includes
restrictions on the company's ability to make  distributions to its shareholders
over certain  amounts.  At December 31, 1997, the company was in compliance with
these covenants.


                                      -34-

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     During  1997,  the company  also  obtained a $5 million  unsecured  line of
credit for general  corporate  purposes.  This line of credit bears  interest at
LIBOR plus 160 basis points and is due on March 31, 1998.  At December 31, 1997,
borrowings under the agreement were $2.5 million.

     On June 25, 1996, in connection with the acquisition of rental property, an
unsecured  note was executed by the company in the amount of $5.5  million.  The
note  bears an  effective  interest  rate of 6.65% per  annum.  Annual  interest
payments are due on January 1, 1998, and 1999, and the principal  balance is due
on June 1, 1999. The note is prepayable at any time, without penalty.

     The fair market value of the borrowings  approximate the recorded  amounts.
No  interest  was  capitalized  in  1997,  1996,  or  1995.  Interest  paid  was
$7,221,104; $1,075,360; and $227,478; for 1997, 1996, and 1995, respectively.

NOTE 4
COMMON STOCK

In April 1997, the company completed its initial firm-commitment public offering
of 5,175,000 shares of its common stock at $10.50 per share. Net proceeds, after
deducting  underwriting  discounts and  commissions  and direct  offering costs,
aggregated  approximately  $49 million and were used to repay $44 million of the
previous line of credit.

     The company  raised  capital  through a series of  continuous  best-efforts
offerings of shares during 1996 and 1995. The company received gross proceeds of
$161,558,958  and $80,142,516  from the sale of 14,687,178  shares and 7,285,683
shares at $11 per share,  including  shares  sold  through the  reinvestment  of
distributions for the years ended December 31, 1996 and 1995, respectively.  The
underwriter received selling commissions and a marketing expense allowance equal
to 7.5% and 2.5%,  respectively,  of the gross  proceeds of shares sold.  During
1996 and 1995, the underwriter earned $16,159,634 and $8,014,252,  respectively.
The net proceeds of the offering,  after deducting selling commissions and other
offering expenses, were $144,798,035 in 1996 and $71,771,027 in 1995.

     The  company  provides  a  plan,  which  allows  shareholders  to  reinvest
distributions  in the purchase of additional  shares of the company.  In January
1997,  the company  adopted a Dividend  Reinvestment  and Share  Purchase  Plan,
("Plan"),which allows any recordholder to reinvest distributions without payment
of any brokerage  commissions or other fees. Of the total  proceeds  raised from
common  shares  during  the years  ended  December  31,  1997,  1996,  and 1995,
$14,198,868; $9,572,255; and $3,904,325; respectively, were provided through the
reinvestment of distributions.

NOTE 5
STOCK INCENTIVE PLANS

Under the company's  Incentive Plan, as amended,  a maximum of 1,237,470 options
could be  granted,  at the  discretion  of the Board of  Directors,  to  certain
officers and key employees of the company.  Under the company's  Directors Plan,
as amended,  a maximum of 533,547  options  could be granted to the directors of
the company.  In 1997, the company  granted  34,235  options to purchase  shares
under the Directors Plan.

     Both of the plans generally  provide,  among other things,  that options be
granted at exercise  prices not lower than the market value of the shares on the
date of grant.  Under the Incentive Plan, options become exercisable at the date
of grant.  Generally  the optionee has up to 10 years from the date on which the
options first become exercisable during which to exercise the options.  Activity
in the  company's  share option plans during the three years ended  December 31,
1997 is summarized in the following table:


<TABLE>
<CAPTION>
                                      1997                    1996                   1995
-------------------------------------------------------------------------------------------------
                                Weighted-Average        Weighted-Average       Weighted-Average
                                        Exercise                Exercise               Exercise
                               Options      Price     Options      Price     Options      Price
-------------------------------------------------------------------------------------------------
<S>                            <C>        <C>         <C>        <C>         <C>        <C>
Outstanding, beginning of year 371,256    $10.99      292,967    $  10.99    250,959    $ 10.98
Granted                         34,235    12.125       78,289       11.00     42,008      11.00
Exercised                           --       --            --          --         --         --
Forfeited                           --       --            --          --         --         --
-------------------------------------------------------------------------------------------------
Outstanding, end of year       405,491    $11.09      371,256    $  10.99    292,967    $ 10.99
Exercisable at end of year     364,591    $11.07      289,456    $  10.99    170,267    $ 10.99
-------------------------------------------------------------------------------------------------
Weighted-average fair value of
option granted during the year            $1.00                  $    .69                   .60
</TABLE>



Pro forma information regarding net income and earnings per share is required by
FASB 123,  which also  requires  that the  information  be  determined as if the
company has  accounted  for its employee  stock  options  granted  subsequent to
December 31, 1994 under the fair value method  described in that statement.  The
fair  value  for  these  options  was  estimated  at the date of  grant  using a
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions for 1997, 1996 and

                                       35
<PAGE>



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1995, respectively:  risk-free interest rates of 6.7%, 6.4% and 6.4%; a dividend
yield of 7.0% for 1995 through 1997;  volatility  factors of the expected market
price of the company's common stock of .161 for 1997 and .122 for 1996 and 1995;
and a weighted-average expected life of the option of 10 years.

     The  Black-Scholes   option  valuation  model  was  developed  for  use  in
estimating the fair value of traded  options which have no vesting  restrictions
and are fully  transferable.  In addition,  option  valuation models require the
input of highly  subjective  assumptions  including  the  expected  stock  price
volatility.  Because the company's  employee stock options have  characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially  affect the fair value estimate,  in
management's  opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

     For purposes of FASB 123 pro forma disclosures, the estimated fair value of
the options is amortized to expense over the  options'  vesting  period.  As the
options are immediately exercisable, the full impact on the pro forma net income
(loss) is disclosed below.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
                                                                   1997                  1996
<S>                                                         <C>                   <C>
Pro forma FASB 123 net income (loss)                        $19,148,373           $ (4,250,453)
As reported net income (loss)                                19,225,553             (4,169,849)
Pro forma FASB 123 diluted earnings (loss) per common share         .59                   (.21)
As reported diluted earnings (loss) per common share                .59                   (.21)
</TABLE>


NOTE 6
RELATED PARTY TRANSACTIONS

RELATIONSHIP WITH APPLE RESIDENTIAL INCOME TRUST

In August 1996,  Glade M. Knight,  Chairman and Chief  Executive  Officer of the
company,  established  Apple  Residential  Income Trust, Inc. for the purpose of
acquiring apartment communities in Texas. Companies owned by Mr. Knight provided
advisory,  property management and asset acquisition services to Apple. In March
1997, the company entered into subcontract arrangements with the companies owned
by Mr. Knight to provide property  management  services and advisory services to
Apple.  Property  management  fees are 5% of monthly gross revenues plus certain
expense reimbursements. Advisory fees are .1% to .25% of total capital raised by
Apple based on the financial  performance  of Apple as defined in the agreement.
The amount of fees  received by the  company  under the  contracts  in 1997 were
$822,934,  and direct  expenses  associated  with providing  these services were
$355,928.

     During  March 1997,  the company  acquired  all the assets of Apple  Realty
Group,  Inc., which provided real estate  acquisition and disposal  services for
Apple.    The   sole   asset   of   Apple   Realty    Group,    Inc.   was   the
acquisition/disposition  contract with Apple which expires on October 2001.  The
company  paid  $350,000  cash and issued  stock  valued at  $1,650,000  for this
contract.  Under the terms of the contract,  Apple pays a real estate commission
equal to 2% of the purchase  price of the  properties  acquired.  The company is
amortizing its purchase of this contract over the anticipated total acquisitions
by Apple during the contract period.  For 1997, the company received  $1,031,066
in real estate  commissions  under this contract and  amortized  $546,000 of the
purchase price of this contract.

     Apple  granted  the  company a  continuing  right to own 9.8% of the common
shares of Apple at its selling price, net of selling commissions. In April 1997,
the company  purchased  417,778  shares of Apple for  $3,760,000.  These  shares
represent approximately 3% of the common shares of Apple outstanding at December
31, 1997. Apple shares are sold under a "best efforts"  offering,  and no market
exists  for  trading  of  Apple  shares.  Dividend  income  from  the  company's
investment in Apple was $253,172 in 1997.

     Apple also  granted the  company a first  right of refusal to purchase  the
business and properties of Apple.

RELATIONSHIP WITH ADVISORY, MANAGEMENT AND ACQUISITION COMPANIES

Prior to September 30, 1996, the company operated as an "externally advised" and
"externally  managed" REIT.  Cornerstone  Advisors,  Inc. served as the advisor,
Cornerstone   Management  Group,  Inc.  served  as  the  property  manager,  and
acquisition  services were provided by Cornerstone  Realty Group,  Inc. Glade M.
Knight,  Chairman and Chief  Executive  Officer of the company,  held all of the
stock of Cornerstone  Advisors,  Inc.,  Cornerstone  Management  Group, Inc. and
Cornerstone  Realty Group, Inc.  (collectively,  the "External  Companies").  By
agreement,  Mr. Knight held part of the stock of the External  Companies for the
account and interest of Stanley J. Olander,  Jr., Chief Financial Officer of the
company, and Debra A. Jones, Chief Operating Officer of the company.

                                      -36-

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     As of October 1, 1996, the company  entered into a series of  related-party
transactions with the External Companies, the effect of which was to convert the
company into a  "self-administered"  and  "self-managed"  REIT. The transactions
were unanimously approved by the independent members of the Board of Directors.

     To effect the  transaction,  the company agreed to issue 1.4 million shares
to Cornerstone  Management  Group, Inc. in exchange for the assignment of all of
its rights and interest in, to and under,  its  management  agreements  with the
company. The company issued 700,000 shares on October 1, 1996 and 700,000 shares
on  September  30,  1997.  The   consideration   for  the  transaction   totaled
approximately $15.4 million based upon the fair market value of $11 per share of
the  com-pany's  common  stock.  Imputed  interest of $402,907 and $134,302 were
recognized in 1997 and 1996, respectively, related to issuance of 700,000 shares
in  September  1997.  In  addition,  on  October  1,  1996 the  company  paid to
Cornerstone  Realty Group,  Inc. and Cornerstone  Advisors,  Inc.  $1,325,000 in
exchange for the  assignment by them of all of their rights and interests in, to
and under, their property acquisition  agreement and advisory agreement with the
company.  Immediately following the assignment by each of the External Companies
of its rights and  interest in, to and under,  its  respective  agreements,  the
company  terminated  such  agreements.  The  consideration  for all of the above
transactions, plus related transaction costs and imputed interest, was accounted
for as a termination of the management administration contracts.

     Also on October 1, 1996, the company paid to Cornerstone Realty Group, Inc.
$100,000  and  paid to Glade  Knight  $350,000  for the  personal  property  and
building, respectively, located at 306 E. Main Street, Richmond, Virginia, which
serves as the principal  executive office of the company.  The company also paid
approximately  $138,000 to certain  lenders,  representing  the balance  owed on
certain  automobile loans, in exchange for the conveyance by Cornerstone  Realty
Group, Inc., to the company of such automobiles.

     Prior to the October 1, 1996 transaction,  Cornerstone Advisors,  Inc. (The
"Advisor")   was  the  advisor  to  the  company  and  provided  its  day-to-day
management.  The  Advisor  earned  a  quarterly  fee not to  exceed  .25% of the
company's assets, based on the company's financial performance as defined in the
agreement with the Advisor.  The Advisor earned $295,759 in 1996 and $219,930 in
1995.

     As properties were acquired, the company paid real estate commissions of 2%
of  the  purchase  prices  of  properties  to  Cornerstone  Realty  Group,  Inc.
Cornerstone  Realty Group,  Inc.  earned  commissions  of $1,957,624 in 1996 and
$1,302,550 in 1995.

     In  addition,   the  company  entered  into  agreements  with   Cornerstone
Management Group, Inc. (the "Management Company") to manage the properties.  The
Management  Company earned a management fee equal to 5% of rental income and was
entitled to be reimbursed for certain  expenses.  The Management  Company earned
management   fees  of  $1,243,215  in  1996  and   $2,686,204  in  1995.

OTHER RELATIONSHIPS

Leslie A.  Grandis,  a director  of the  company,  is also a partner in McGuire,
Woods, Battle & Boothe LLP, which serves as counsel to the company. Fees paid to
McGuire, Woods, Battle & Boothe LLP in 1997 were $420,367. Martin Zuckerbrod and
Harry S.  Taubenfeld,  directors  of the  company,  provide  real  estate  legal
services to the company.  Fees paid to Mr. Zuckerbrod and Mr. Taubenfeld in 1997
were $172,078.

NOTE 7
EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per
share:

<TABLE>
<CAPTION>
                                                           1997            1996           1995
------------------------------------------------------------------------------------------------
<S>                                                <C>               <C>           <C>
Numerator:
   Net income (loss)                               $ 19,225,553      $(4,169,849)  $ 5,229,715
   Numerator for basic and diluted earnings          19,225,553       (4,169,849)    5,229,715
Denominator:
   Denominator for basic earnings per
      share-weighted-average shares                  32,617,823       20,210,432     8,176,803
Effect of dilutive securities:
      Stock options                                       2,014               --           343
------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share-
      adjusted weighted-average shares and
      assumed conversions                            32,619,837       20,210,432     8,177,146
------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per common share $        .59      $      (.21)   $      .64
================================================================================================
</TABLE>

                                      -37-

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8
QUARTERLY FINANCIAL DATA
(UNAUDITED)

The  following is a summary of  quarterly  results of  operations  for the years
ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                          First          Second           Third         Fourth
1997                                    Quarter         Quarter         Quarter       Quarter
------------------------------------------------------------------------------------------------
<S>                                 <C>            <C>             <C>            <C>
Revenues                            $15,385,285    $ 17,354,804    $ 18,967,143   $ 20,263,392
Income before
   interest income (expense)          5,592,743       6,005,325       6,900,266      7,957,424
Net income                            4,001,740       4,529,304       5,336,846      5,357,663
Basic and diluted earnings
   per common share                         .14             .14             .15            .15
Distributions per share                     .25             .25             .25            .25

1996
------------------------------------------------------------------------------------------------
Revenues                            $ 6,536,129    $  8,649,906    $ 11,469,251   $ 13,606,388
Income (loss) before
   interest income (expense)          2,142,429       2,931,010       3,471,329    (11,573,950)
Net income (loss)                     2,171,887       2,749,676       3,306,208    (12,397,620)
Basic and diluted earnings
   per common share                         .16             .16             .15           (.45)
Distributions per share                   .2475            .248           .2485           .249
</TABLE>

(a)  Included  in  the  1997  and  1996  operating   results  are  $402,907  and
$16,526,012,  respectively, of management contract termination expense resulting
from the company's conversion to "self-administered"  and "self-managed" status.
See Note 6 to the consolidated financial statements.

(b) The 1996 and first three  quarters of 1997  earnings per share  amounts have
been  restated to comply with  Statement of Financial  Accounting  Standards No.
128, "Earnings per Share."

NOTE 9
PRO FORMA INFORMATION
(UNAUDITED)

The following  unaudited pro forma  information for the years ended December 31,
1997  and 1996 is  presented  as if (a) the  company  had  qualified  as a REIT,
distributed all of its taxable income and, therefore, incurred no federal income
tax expense  during the period;  and (b) the company had used  proceeds from its
best efforts offering to acquire the properties,  for properties acquired before
the completion of the offering.  Properties acquired after the completion of the
offering were assumed to be acquired  using the company's line of credit or from
proceeds  of  an  equity  offering  completed  in  April  1997.  The  pro  forma
information  does not  purport  to  represent  what  the  company's  results  of
operations  would  have been if such  transactions,  in fact,  had  occurred  on
January 1, 1996,  nor does it purport to represent the results of operations for
future periods.

<TABLE>
<CAPTION>
Unaudited Pro Forma Totals                                             1997               1996
------------------------------------------------------------------------------------------------
<S>                                                             <C>               <C>
Income                                                          $ 80,147,371      $ 69,510,225
Net income (loss)                                                 20,342,399        (1,102,351)
Basic and diluted earnings (loss) per common share                       .58              (.04)
</TABLE>

The pro forma information  reflects adjustments for the actual rental income and
rental  expenses  of 11 of the 13  properties  acquired in 1997 and 19 of the 21
properties acquired in 1996 for the respective periods in 1997 and 1996 prior to
acquisition  by the  company.  Net  income has been  adjusted  as  follows:  (1)
property  management  and  advisory  expenses  have been  adjusted  based on the
company's   contractual   arrangements   in  effect  until  the  contracts  were
terminated; (2) interest expense has been increased for the properties funded by
the  company's  line of credit based on market rates at the time of  acquisition
available to the company for applicable  properties;  (3) the number of weighted
average  common  shares  outstanding  was  increased  for  properties  funded by
proceeds from equity offerings;  and (4) depreciation has been adjusted based on
the company's basis in the properties.

                                      -38-

<PAGE>


CORPORATE HEADQUARTERS                  STOCK LISTING
Cornerstone Realty Income Trust         New York Stock Exchange
306 East Main Street                    Symbol TCR
Richmond, Virginia 23219
(804) 643-1761                          ANNUAL MEETING
(804) 782-9302 FAX                      We invite  shareholders  to  attend  the
                                        annual meeting of  shareholders  at 2:00
                                        p.m.  on May 5 at The  Cornerstone,  107
WORLDWIDE WEB SITE                      West Broad Street in Richmond, Virginia.
www.cornerstonereit.com

TRANSFER AGENT                          DIVIDEND REINVESTMENT PLAN
First Union National Bank               We offer shareholders the opportunity to
Corporate Trust Operations              purchase  additional  shares  of  common
1525 West W.T. Harris Boulevard         stock   through  the   reinvestment   of
Building 3C3                            distributions.   For  more  information,
Charlotte, North Carolina  28288-1153   please contact your  investment  advisor
(800) 829-8432                          or Corporate Services at (804) 643-1761.


INDEPENDENT AUDITORS                    10-K REPORT
Ernst & Young LLP                       Sharesholders  are  welcome to a copy of
901 East Cary Street                    our  annual  report  on  From  10-K,  as
Richmond, Virginia  23219               reported to the  Securities and Exchange
(804)  344-6000                         Commission.  Please address  requests to
                                        Corporate   Services  at  our  corporate
                                        headquarters.

GENERAL COUNSEL                         COPORATE SERVICES
McGuire, Woods, Battle                  For  additional  information  about  the
& Boothe LLP                            company,  please contact David McKenney,
One James Center                        Vice President of Corporate Services, at
901 East Cary Street                    (804) 643-1761.
Richmond, Virginia 23219
(804) 775-1000

MEMBER
National Association of Real Estate
Investment Trusts (NAREIT)
The Institute of Real Estate
Management (IREM)